With President Obama signing the big financial regulation bill today, Washington will feel like it's done enough for a while when it comes to making new rules for banks and Wall Street. Next on its 'to do' financial policy checklist is housing. After all, the biggest hole in the Dodd-Frank bill was a complete lack of reform for the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
But one of the legislation's chief architects, House Financial Services Chairman Barney Frank (D-MA), has already indicated that the GSEs and housing policy will be a major focus going forward, with hearings starting in September. The White House has also said that officials will release a new housing strategy sometime next year. Experts are also beginning to weigh in. A special series from The Economist provides some good ideas. Another piece in the recent edition of the National Review also argues for key changes. What should be done?
Back in April, the Treasury provided a good list of seven questions for comment on Housing Policy. If you want to weigh in, you'd better act fast, because they're due today. Here are the seven questions, and some very brief responses I would provide, based on my pre-journalism background in economics, mortgage consulting and asset-backed securities:
1. How should federal housing finance objectives be prioritized in the context of the broader objectives of housing policy? [Commentary could address: Policy for sustainable homeownership; rental policy; balancing rental and ownership; how to account for regional differences; and affordability goals.]
Really, the easiest and most effective solution would be for the government to get out of the housing market entirely. But since that isn't likely to happen, at the very least the ends of providing affordable housing and liquidity should be sought separately. One big problem with Fannie and Freddie was that these two goals became intertwined.
The affordable housing function is probably a more appropriate area for government involvement, in terms of priority. Therein, renting is a more sensible option for low-income individuals who seek government assistance. The market can evolve through time to provide its own liquidity, once weaned off government-guaranteed funding.
2. What role should the federal government play in supporting a stable, well-functioning housing finance system and what risks, if any, should the federal government bear in meeting its housing finance objectives? [Commentary could address: Level of government involvement and type of support provided; role of government agencies; role of private vs. public capital; role of any explicit government guarantees; role of direct subsidies and other fiscal support and mechanisms to convey such support; monitoring and management of risks including how to balance the retention and distribution of risk; incentives to encourage appropriate alignment of risk bearing in the private sector; mechanisms for dealing with episodes of market stress; and how to promote market discipline.]
Ideally, the federal government shouldn't play any role in supporting the mortgage market. If it merely removes its influence, then the market will actually function much better in the long-run. Of course, thanks to political pressures, this dream will never come to be. As a result, any interference should be transparent and based on very conservative assumptions. Any guarantees or other support the government provides should be brought on balance sheet.
3. Should the government approach differ across different segments of the market, and if so, how? [Commentary could address: Differentiation of approach based on mortgage size or other characteristics; rationale for integration or separation of functions related to the single-family and multi-family market; whether there should be an emphasis on supporting the production of subsidized multifamily housing; differentiation in mechanism to convey subsidies, if any.]
Again, simpler is better. If the government insists on promoting homeownership, fine, but that goal implies it should help those who are on the verge of affording a home, not to help those who can afford a modest home buy a bigger one. As already alluded to, any guarantees or other such support should be on budget and pre-funded in full by the federal government, so taxpayers aren't dealt unexpected losses.
4. How should the current organization of the housing finance system be improved? [Commentary could address: What aspects should be preserved, changed, eliminated or added; regulatory considerations; optimal general organizational design and market structure; capital market functions; sources of funding; mortgage origination, distribution and servicing; the role of the existing government-sponsored enterprises; and the challenges of transitioning from the current system to a desired future system.]
Ideally, Fannie and Freddie should be wound down and eliminated. This could be done by reducing their origination limits by one-tenth of their current level each year over the next decade. During this time, the market would be able to evolve to develop private-sector solutions for mortgage funding. (See #7 for one such tactic.) Affordable housing initiatives can be done through purely public agencies like the FHA, which has a relatively good track record.
5. How should the housing finance system support sound market practices? [Commentary could address: Underwriting standards; how best to balance risk and access; and extent to which housing finance systems that reference certain standards and mortgage products contribute to this objective.]
It's an unfortunate state of affairs that investors and underwriters are so inept today that the government would need to promote market discipline. Of course, if funding weren't so easy to obtain thanks to government involvement, and originators treated mortgage dollars as a precious commodity, then perhaps they would take more care with handing it out.
The best thing the government can do here is require greater transparency in mortgage-related financial transactions, like mortgage-backed securities. Anyone who wishes to invest in a mortgage security needs to have all loan-level data available to perform robust analysis. With any luck, the past few years have taught MBS investors a thing or two about the importance of evaluating risk. And if no one is willing to buy junk, the mortgage companies won't be able to originate it.
6. What is the best way for the housing finance system to help ensure consumers are protected from unfair, abusive or deceptive practices? [Commentary could address: Level of consumer protections and limitation; supervising agencies; specific restrictions; and role of consumer education.]
There are two keys here: disclosure and education. Loan terms need to be crystal clear so that anyone can understand what their payment will be throughout the life of the mortgage. But some broader knowledge of basic budgeting, finance, and math would certainly help some people. The new consumer bureau could create opportunities to better educate those who feel their financial literacy is inadequate. This could be accomplished a number of ways. One example might be electronic computer courses offered through public access facilities like libraries.
7. Do housing finance systems in other countries offer insights that can help inform U.S. reform choices?
Certainly. One prime example is the covered bond market in Europe. Those countries don't have GSEs, but still manage to miraculously have a mortgage market. One way this is accomplished is through covered bonds, which allow investors a safe, predictable bond secured by mortgage assets held on a bank's balance sheet. This is win-win scenario, since banks have an incentive to originate strong loans, and investors face less of the risk inherent in mortgage-backed securities.